Boom-Bust Cycle, Asymmetrical Fiscal Response and the Dutch Disease

IMF Working Papers, April 1, 2010

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Objective: Examine the behavior of expenditure policy during boom-bust commodity price cycles and implications for real exchange rate movements.
Model: Introduces a Dutch disease model with downward rigidities in government spending to revenue shock; model implies a decoupling between real exchange rate and commodity price movement during busts.
Empirical test: Panel data for 32 oil-producing countries over the period 1992 to 2009.

Aggregate finding structure:
- Results are threefold.
Finding 1 — Spending composition and exchange rate:
- Change in current spending has a stronger impact on the change in real exchange rate compared to capital spending.
Finding 2 — Asymmetry and stickiness:
- Current spending is downwardly sticky, but increases in boom time.
- Capital spending behaves conversely (i.e., less sticky downward, and responds differently across cycle phases).
Finding 3 — Role of fiscal rules:
- Limited evidence that fiscal rules have helped reduce the degree of responsiveness of current spending during booms.
- Evidence that fiscal rules are associated with a significant reduction in capital expenditure during busts while responsiveness to boosts is more muted.
Implication: The identified asymmetry raises concerns about potential adverse consequences on economic performance in oil-producing countries.

Fiscal management:
- Downward rigidity in current spending can decouple exchange rate adjustment during busts, potentially complicating macroeconomic stabilization.
- Fiscal rules appear more effective at restraining capital expenditure during busts than at moderating current spending during booms.
Potential adverse consequences:
- Asymmetrical fiscal responses (sticky current spending up in booms, sticky down in busts; capital spending cut in busts) may harm long-term economic performance in oil-producing countries.
Policy focus:
- Consideration needed on designing fiscal frameworks that address asymmetric responses of current and capital spending across commodity cycles.

IMF Working Papers — Boom-Bust Cycle, Asymmetrical Fiscal Response and the Dutch Disease (Kareem Ismail, Rabah Arezki, April 1, 2010).

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